Measuring the Risk of Large Losses

Kay Giesecke, Thorsten Schmidt and Stefan Weber

Volume 6, Number 4, Fourth Quarter 2008

Risk management is an important component of the investment process. It requires quantitative measures of risk that provide a metric for the comparison of financial positions. In this expository note we give an overview of risk measures. In particular, we contrast different risk measures with respect to their sensitivity to potentially large losses due to market wide shocks. The industry standard value at risk exhibits many deficiencies. It does not account for the size of the losses and may penalize diversification. We compare value at risk to alternative risk measures including average value at risk and the less well know but superior utility-based shortfall risk.